«October 31, 2013 A Look Back The month of September marked the five year anniversary of the collapse of Lehman Brothers. Stocks certainly have had ...»

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“I have learned that the key to long-term success in investing is to balance

confidence with the humility to recognize when the facts are no longer consistent

with one’s original investment thesis.”

—William Ackman commenting after losing almost $500 million on his failed investment in J.C. Penny

October 31, 2013

A Look Back

The month of September marked the five year anniversary of the collapse of Lehman Brothers. Stocks

certainly have had quite a run since that period, advancing by approximately 155%, as measured by the S&P 500 from their March 2009 lows.

It is clearly more difficult to find bargains today than when stocks like CBS traded for $6 per share (current price ~$59.00), or when Saks was trading at a $1.85 (current price ~$16.00) and is on its way to being acquired. For the moment, the days of six or seven baggers (stocks rising six-or- sevenfold) are over.

Politics and policy dominated the markets in the third quarter, especially during the eventful, nerve racking and surprising final weeks that left the markets in a state of heightened uncertainty.

A trifecta of events, that included the Federal Reserve's decision not to commence the tapering of its $85 billion per month bond buying program, which surprised most pundits; the government shut down, and the potential for the debt ceiling not to be raised which almost contributed to a technical default on U.S. debt obligations, all contributed to the uncertainty.

After closing at 1,725.52 on September 18th, the day of the Fed decision to continue with tapering; the Standard & Poor's 500- stock index fell on seven of the last eight trading days of the quarter. Even with the weakness at the end of the quarter, the S&P 500 gained a very respectable 5.24% for the past three months. The more speculative Russell 2000 and the NASDAQ Composite fared even better advancing 10.21% and 10.82% respectively. The Dow Jones Industrial average was the laggard advancing 2.12%.

 The current bull market is approximately 54 months long and the average bull market since 1921 has been 29 months.

 The average price increase from the bottom in the past 17 bull markets has been ~153% vs. the ~155% jump in the S&P 500 from March 9, 2009.

 The longest and strongest bull market which ended with the bursting of the tech bubble lasted 113 months and climbed 417%.

 The six bull markets of the 17 that have occurred since 1921 have seen better stock gains than the current one.

 The average price to earnings ratio since 1999 has approximated 16.6x. The projected 2014 P/E of the S&P 500 is currently around 14.5x.

Typically bull markets come to an end following a period of extraordinary performance. In other words, some of a bull market's best returns occur right before it dies. Remember the NASDAQs performance in the 4th quarter of 1999 when it advanced ~48%? The NASDAQ hit its all-time high four months later, just before the bubble burst. In the months leading to market tops there are striking similarities that often occur.

Growth stocks outperform value stocks and small capitalization stocks outperform their larger brethren. There are early signs today that such a trend has commenced.

So let us revisit the grand daddy of all bull markets, the Internet craze and NASDAQ 5000 to see if there are any similarities with today's richest companies in terms of stock market valuations and the leaders of

that era. Bill Gates stated at that time:

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Currently there are a number of companies that have captured Wall Street's fancy each with multiples of 100x or more. They include names like Netflix, Zillow and LinkedIn. Tesla is another example of a high multiple stock. The company delivered just 1400 cars in July or about 1% of Ford Motor Company’s sales for the same month. Today Tesla commands a market valuation of over $21 billion.

This is about a third of Ford's market cap and approximately triple that of Fiat which is the majority owner of Chrysler.

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The individual investor has not taken the Fed's bait, and has Zillow $3.6 150x 2014 not returned to the equity market as measured by significant mutual fund inflows. And who can blame them? Over the last LinkedIn $28 161x 2013 decade or so they have been badly bruised by three financial bubbles bursting: First came the Internet bubble, followed by a real estate collapse of monumental proportion and finally the financial meltdown which almost destroyed the entire economic system.

Individual investors usually show up late for the party, but they usually do show up. As a result of both individual and institutional investors fleeing the equity markets en masse during the 2007- 2009 period, common stocks are currently under owned, while bonds have a much higher weighting than normally is the case. A higher asset allocation into stocks could prolong the stock market advance.

To summarize, the overall stock market is probably fairly valued. Stocks are not on the bargain basement table as they were in 2008-2009. Temper your expectations in terms of expected future returns, and be wary of momentum stocks with triple digit P/E ratios. A higher cash balance might also be appropriate.

-3Seinfeld Turns ‘Nothing’ Into a $3bn Sale It never ceases to amaze us the value of popular content. Below is an excerpt from a Financial Times article detailing the enormous monetary success the television show Seinfeld is still achieving well more than a decade after its series finale. As the saying goes, “content is king.”

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Sometimes It’s Better To Be Rejected!

The Dow Jones Industrial Average which supposedly is a bellwether for the overall economy and is the index most recognized by retail investors, recently underwent a reshuffling where Bank of America, Alcoa, and Hewlett-Packard were replaced with Goldman Sachs, Nike, and Visa. According to a recent study by three researchers at Pomona College and reported in the Wall Street Journal on October 7 th 2013, it is better (at least in terms of stock market performance), to be kicked out of the index. According to their research which dates back to 1929 and extends through 2005: The companies that were kicked out of the index gained an impressive 173% on average over a five year period as opposed to a mere 65% for the new entrants.

If Obesity Were a Stock We Would Want to Own It.

One of the stocks we have recently added to many of the accounts we manage is Weight Watchers.

Part of our investment thesis is that obesity is currently a serious epidemic in the U.S. (almost 70% of Americans are classified as obese or overweight according to the National Institutes for Health) and the Weight Watchers program is one of the most scientifically proven methods to combat this problem. Due to some recent company missteps involving capital allocation as well as the misperception at least in our view that free apps available on the internet will continue to take market share away from Weight Watchers (we believe these apps do not lead to a sustained weight loss for most people and therefore are not a long-term competitive threat): This has caused the stock to sell at a significant discount to our estimate of intrinsic or private market value. Our thesis about the efficacy of the Weight Watchers program compared to the free apps available on the internet was reaffirmed by a a recent study conducted at Baylor College of Medicine that was reported in an article in The American Journal of Medicine that said, “that overweight and obese adults following a community-based weight loss intervention, namely Weight Watchers, lost significantly more weight than those who tried to lose weight on their own (10.1 lbs. vs. 1.3 lbs. at six months). Those in the Weight Watchers group were provided with three

-4access routes - group meetings, mobile applications, and online tools - and further analysis found those who used all three access routes together lost the most weight.

Of the 292 overweight and obese adults who participated in the six-month trial, those assigned to the Weight Watchers group were eight times more likely to achieve at least a five percent weight loss than those assigned to lose weight on their own. The five percent weight loss threshold is important because, according to the CDC, it is the amount associated with improved health markers, such as cardiovascular risk factors and blood sugar levels. While there are more than 80 peer reviewed publications that establish the efficacy of the Weight Watchers community-based approach, this is the first study that included the three complementary ways to access the program - meetings, mobile applications and online tools - in the study design.” [emphasis added] Among the 147 participants assigned to the Weight Watchers group, those using all three access routes to a high degree (defined as more than 50 percent of the weekly meetings and using the mobile applications and/or online tools two or more times a week) had the greatest weight loss at 19 lbs. Those using two access routes to a high degree lost 9.5 lbs. and those using one lost 9.3 lbs.

Meeting attendance was the strongest predictor of weight loss compared to usage of the other access routes.

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Regulators Have Very Short Memories.

As you may remember approximately a decade ago, many of Wall Street’s largest banks were forced to enter into a settlement that totaled well over one billion dollars due to the fact that analysts employed by the firms’ equity research divisions promoted companies going public, even though privately they were quite bearish on the same companies. This bad behavior took place to help the banks secure lucrative investment banking relationships with the issuing companies.

Now as a result of the recently enacted JOBS Act, many of the restrictions that were in place which were designed to protect investors have been removed or significantly restricted for “emerging growth companies.” An emerging growth company is defined as a company with under $1 billion in annual revenue.

While this regulation will not affect large capitalization companies: Do not think this is a small exception that can only be taken advantage of by micro cap companies. For example, well-known and soon to be public company Twitter, has already taken advantage of some of the JOBS Act’s loose restrictions involving financial disclosures related to its upcoming I.P.O.

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Utilizing the Government to Obtain Inside Information Insider trading has been in the headlines recently, as the government has undertaken an aggressive crackdown on insider trading the scope of which that has not been seen since the days of Michael Milken and Drexel Burnham Lambert. Hedge funds have been at the center of this probe and the most high profile investigation has been that of SAC Capital.

As detailed in a recent article that appeared in the Wall Street Journal on September 23, 2013, one source the hedge fund industry is gravitating towards to obtain material non-public information (which is perfectly legal in this instance), is the U.S. government via the Freedom of Information Act (FOIA).

According to the article, hedge fund firms such as SAC Capital have used this act as part of their investment process. The article stated that SAC Capital and its affiliates from 2008-2012 filed a total of 92 FOIA requests with the FDA. This is more than any other firm that files requests on their own behalf (some firms utilize outside consultants that make requests for them, due to the fact that it is public record what requests are made and by whom).

“A review by the Wall Street Journal of more than 100,000 of the roughly three million FOIA requests filed over the past five years, including all of those sent to the FDA, shows that investors use the process to troll for all kinds of information.

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